Revisiting ‘Subprime’ Mortgages

“Subprime” has been a dirty word since the freewheeling mortgage lending spree that ultimately brought down the economy and propelled millions of homeowners into foreclosure.

The term simply refers to loans made to borrowers who do not fit the standards for a prime mortgage loan, as defined by Fannie Mae and Freddie Mac. But after the housing market crash, subprime became almost synonymous in some people’s minds with the insidious loan products of the previous decade — those that didn’t require proof of income, or with negative amortization, or that allowed the borrower to decide how much to pay each month.

It is not surprising that the lenders who are now dealing in the subprime area are choosing different terminology to describe their products. The preferred adjectives these days are nonprime, non-QM (for qualifying mortgage) or “alternative.”

“We’re not really running from the word subprime,” said Tom Hutchens, the senior vice president for sales and marketing at Angel Oak Mortgage Solutions in Atlanta. “It’s really just educating people about what the 2015 subprime is, no matter what their predisposition to the word is.”

The kinds of nonqualified loans Angel Oak and many other nonbank lenders are now offering look more like the subprime products of the late 1990s, Mr. Hutchens said. “Then, each layer of credit risk was mitigated with something else,” he said. “If you had some type of credit issue, for example, you had to put another 5 percent down or your rate was slightly higher.”

Angel Oak’s nonprime rates range from around 5.5 percent to up to 9 percent for borrowers with a lower credit score or recent credit event, such as a foreclosure within the past year, he said.

The biggest category being targeted consists of borrowers who do not qualify for a prime loan because of a single foreclosure or bankruptcy related to the recession. “They’re not bad people — they had a life event,” Mr. Hutchens said.

Keith T. Gumbinger, the vice president of HSH.com, a financial publisher, noted that these borrowers must, like prime borrowers, meet the proof of ability-to-pay requirements put in place by regulators after the mortgage crisis. And that, along with the banning of many of the riskier mortgage products, makes this version of subprime quite different from the last go-round, he said. “The fact is,” he added, “it’s a necessary component of the marketplace. And it serves a function after coming out of a pretty severe recession.”

While a number of hedge funds and private equity firms are readily putting up the money to make these loans, the vast majority of subprime mortgages are being held in portfolio. The secondary market has yet to warm to the return of securities backed by subprime loans, and that should keep the volume of subprime loans from expanding much in the near future, said Noelle Savarese, a portfolio manager at MatlinPatterson, a global alternative asset manager.

“We do not believe there is enough demand for that product” for the market to grow in a substantial way, she said. “The investor community is still licking its wounds from the crisis.”

Investors will want stronger protections written into representations and warranties, and more credit enhancement, said Marc Rosenthal, who manages a mortgage bond fund with Ms. Savarese. “But right now,” Ms. Savarese said, “lenders can’t charge these borrowers high enough rates to make it economically sound to sell these securities.”

Citing figures from Bank of America, Mr. Rosenthal noted that in 2006, subprime securitization volume hit a high of $534 billion. This year, the figure may be less than $10 billion, he said.